Thursday, October 8, 2009

Whenever a politician comes up with a clever scheme that purports to solve all kinds of problems—such as ObamaCare, which promises to cover nearly everyone with generous healthcare insurance without taxing anyone but the very rich—I immediately think there must be some very big unintended consequences lurking beneath the surface. And not surprisingly there are, as James Capretta points out in an article in The New Atlantis. (HT: Greg Mankiw)

Here's my quick summary of both Capretta and Mankiw's comments, but read theirs as well to fill in the details I'm leaving out. According to the CBO, for families earning at the poverty line in 2016 ($24,000), government subsidies for healthcare insurance would be worth about $16,500 per year. If a family managed to double its income to twice the poverty line ($48,000), healthcare subsidies would drop to about $9,072. That means that a family earning $24,000 would face a 30% marginal tax rate just from the impact of reduced federal subsidies. But on top of that, the same family would find that the earned income tax credit would be phased out, and it would be subject to the 15% income tax rate, payroll taxes of 12%, and state income taxes. Add it all up and a poor family struggling to rise up out of poverty could face an effective marginal tax rate of up to 80%.

Bottom line: schemes which redistribute income massively from the very rich to the very poor can end up enslaving those at the bottom rungs of the income ladder, by imposing huge effective penalties on additional work. As Milton Friedman said, "there is no free lunch."